Licensing is a method of commercializing your invention. When you strike a licensing deal, you grant another company the right to make, use, and/or sell products based on your “intellectual property.” The intellectual property at the heart of any such licensing agreement is typically covered by a patent you’ve been issued. The party granting the rights is the “licensor,” and the party acquiring the rights is the “licensee.”
The first and most important thing you can do when negotiating a licensing agreement for your small business is to work with an intellectual property attorney who is skilled in the area of licensing. While it may be expensive, it’s absolutely worth it. If you can’t afford to pay upfront, find an attorney who is willing to work upfront and defer the fees until the licensing agreement is executed and you get that first check.
When you license your invention, you should expect revenues to come your way in two basic ways - as a “royalty,” typically in the range of 5% to 15% of unit selling price, and as an advance payment of some kind, the amount of which is dependent on many variables.
Whatever amount is agreed to for the royalty, make sure you clearly define what the royalties will be based on. For instance, if you strike a deal in which you receive 5% of the net sales of the licensee, make sure “net sales” is completely defined. For example, it might be “gross sales minus returns, shipping, and taxes.” The important thing is to ensure that the licensee has no chance to be “creative” in calculating the amount on which your royalties will be based.
Key components of licensing agreements
- Exclusivity: Do you intend to offer the rights to your patent to one licensee exclusively, or do you intend to license the intellectual property to a wide variety of licensees? There are pros and cons to each scenario. When licensing exclusively, you will likely be able to negotiate a higher royalty amount and an advance against future royalties from the exclusive licensee. On the downside, however, you will be counting on this single licensee to be successful in commercializing your invention and generating royalties to you. A non-exclusive license strategy means that you will rely less heavily on one of the licensees and hope that across the group of licensees, you will realize your royalty goals. The downside is that the royalty amounts for a non-exclusive license typically are much less per licensee.
- The Territory: Do you intend to grant licensing rights for a single country, several of them, or the world? Again, the broader the territory rights, the greater your royalty amount should be.
- The Markets: If you have a technology with a wide variety of potential applications and markets, you can actually carve out certain rights to grant to one licensee while holding back rights to award to other potential licensees for other applications or markets.
- Royalty Payment Terms: Will the royalties be paid annually, quarterly, or monthly? Quarterly often works well for both parties.
- Reporting and Right to Audit: Make sure that the licensee is required to provide you with a detailed report of all units sold, and if applicable, details on returns, shipping costs, taxes, and any other expenses which impact the royalty calculation.
- Indemnification: Make sure that the licensee is required to indemnify you against any litigation arising from any actions taken by the licensee. In certain cases, you can even require that the licensee name you as “additional insured” on the licensee’s liability policy. The important point is that you are not held responsible for any of the licensee’s actions.
- The Advance Payment: When negotiating an advance to be paid to you by the licensee, make sure you understand whether this is a pure upfront payment, or whether it is an “advance” against future royalties. If it is an advance, the licensee will have the right to recoup this payment by holding back royalties that would otherwise be paid to you until they recoup the amount of the advance is recouped by the licensee. When negotiating the terms by which an advance payment can be recouped by the licensee, attempt to negotiate that the advance is not recouped on a dollar for dollar basis, but rather by some rate that will provide you with some cash flow from royalties while at the same time paying down the advance. An example of this strategy is that for every dollar of royalty that would otherwise be held to pay down the advance, require that 50% goes to you and 50% is withheld to pay down the advance.
- The Guaranteed Annual Minimum Royalty: In some cases, particularly when an exclusive licensing arrangement is negotiated, you can require that the licensee be responsible for paying you a minimum royalty amount regardless of whether a single unit sells or not. This amount is typically arrived at as a number that the company is willing to pay to retain the intellectual property rights (even if sales do not meet expectations), and the minimum number which you, the licensor, are willing to accept for licensing your rights. There are many ways by which the specific number is determined, but common factors include agreeing on what a likely minimum number of annual unit sales will be.
- Termination: You must know going in if and how you can get out of a license agreement if the licensee is not performing to your expectations. There are many strategies for this, but the important thing is to make sure you understand if and how the agreement can be terminated. This is a particularly important term that clearly requires a skilled attorney to negotiate.
Our Bottom Line
Know what you want and match that with the various common components of a licensing deal before starting to negotiate with a licensee. You only get one shot to do it right and close a licensing agreement on your invention.